The recent decision of the Tax Appeal Tribunal in Case No. TAT-CA-B/2023/005 provides significant guidance on the application of transfer pricing principles under Maldivian tax law. In particular, the Tribunal clarified the role of comparability analysis in determining whether a related-party financing arrangement satisfies the arm’s length principle and established a framework for assessing whether a purported loan should be treated as debt or recharacterised as an equity contribution.

Drawing extensively from the OECD Transfer Pricing Guidelines and the OECD Model Tax Convention, the decision reinforces the principle that the tax treatment of a transaction depends on its economic substance rather than its contractual form. The Tribunal also considered the deductibility of interest incurred on borrowings used to settle tax liabilities, providing further clarification on the scope of deductible expenditure under the Business Profit Tax Act (“BPTA”).

Background and Core Issues

The dispute arose from MIRA’s audit of the taxpayer, which involved two separate categories of borrowing.

The first concerned a related-party financing arrangement under which the taxpayer claimed deductions for interest expenses pursuant to Section 11(a)(5) of the BPTA. MIRA disallowed the deduction on the basis that the arrangement was not a bona fide loan and did not satisfy the arm’s length principle under Section 29(g) of the BPTA.

The second concerned a loan obtained by the taxpayer to settle additional tax liabilities arising from previous tax audits. The taxpayer sought to deduct the interest incurred on this borrowing as an income-related expense. MIRA rejected the deduction, arguing that the borrowing was not undertaken for the purpose of producing income as required under Section 10(a) of the BPTA.

The Tribunal ultimately upheld MIRA’s position on both issues.

Issue One: Comparability Analysis and the Arm’s Length Principle

A central issue before the Tribunal was whether MIRA was entitled to conclude that the related-party financing arrangement was not an arm’s length transaction and therefore did not qualify as a bona fide loan for tax purposes.

The Tribunal observed that while neither the BPTA nor the applicable regulations expressly prescribe a comparability analysis when applying Section 29, such an analysis is nevertheless inherent in the arm’s length principle itself. Since Section 29 requires an assessment of whether related-party transactions have been conducted on arm’s length terms, the Tribunal held that it is necessary to apply the internationally accepted analytical framework used to make that determination.

In reaching this conclusion, the Tribunal referred to the earlier decision in CDLHT v MIRA (2021/HC-A/274), which recognised the importance of comparability analysis in transfer pricing assessments. Building upon that reasoning, the Tribunal confirmed that where MIRA asserts that a transaction is not at arm’s length, a comparability analysis must be undertaken.

OECD Guidance on the Characterisation of Debt

The Tribunal drew extensively on Article 9 of the OECD Model Tax Convention, which permits tax authorities to adjust profits where conditions between associated enterprises differ from those that would have existed between independent parties.

Particular emphasis was placed on the OECD Commentary to Article 9, which explains that transfer pricing analysis is relevant not only in determining whether the interest rate applied to a loan is arm’s length, but also in determining whether a purported loan should be regarded as a loan at all or instead treated as another form of financing, including an equity contribution.

The Tribunal considered this distinction significant. Before assessing whether the terms of a financing arrangement are arm’s length, it may first be necessary to determine whether the arrangement is genuinely debt in substance.

The Two Stages of Comparability Analysis

Referring to paragraph 1.33 of the OECD Transfer Pricing Guidelines, the Tribunal identified two key stages in a comparability analysis.

• Accurate Delineation of the Transaction

The first stage involves accurately delineating the transaction by identifying the commercial and financial relationship between the parties and examining the economically relevant characteristics of the arrangement.

The Tribunal referred to paragraph 1.35 of the OECD Guidelines, which states that before comparisons can be made with uncontrolled transactions, it is necessary to identify the economically relevant characteristics of the controlled transaction.

In other words, the true economic nature of the arrangement must first be established before determining whether comparable independent transactions exist.

• Comparison with Independent Transactions

The second stage involves comparing the accurately delineated transaction with comparable transactions undertaken between independent parties operating in similar circumstances.

However, the Tribunal made an important clarification. If the accurate delineation exercise establishes that the arrangement is not genuinely debt but is instead an equity contribution, there is no requirement to proceed to the second stage of comparison. In such circumstances, the transaction cannot be benchmarked as a loan because it is not a loan in substance.

Determining Whether a Purported Loan is Genuine

The Tribunal further relied on Chapter 10 of the 2022 OECD Transfer Pricing Guidelines, which specifically addresses financial transactions.

Particular attention was given to paragraph 10.10, which recognises that accurate delineation may be used to determine whether a purported loan should be regarded as debt for tax purposes or recharacterised as a contribution to equity capital.

The Tribunal also referred to paragraph 10.12, which identifies a number of economically relevant characteristics that may assist in determining the true nature of a financing arrangement, including:

• The presence or absence of a fixed repayment date;
• The existence of an obligation to pay interest;
• The lender’s ability to enforce repayment of principal and interest;
• The lender’s status relative to other creditors;
• The existence of guarantees or security arrangements;
• The source of repayment and interest payments;
• The borrower’s ability to obtain financing from unrelated lenders;
• The purpose for which the funds were advanced; and
• The conduct of the parties in relation to repayment obligations.

The Tribunal observed that these characteristics must be considered collectively when determining whether an arrangement is genuinely debt or more accurately characterised as equity.

Application of the Principles to the Facts

Having established the applicable legal framework, the Tribunal examined whether MIRA had properly undertaken the accurate delineation exercise.

The Tribunal reviewed MIRA’s audit findings and concluded that MIRA had assessed the economically relevant characteristics of the arrangement. MIRA identified several factors inconsistent with ordinary commercial lending, including the absence of any meaningful repayment history, the lack of a repayment schedule, the absence of guarantees or security arrangements, and other features that departed from ordinary commercial lending practices.

The Tribunal therefore accepted MIRA’s conclusion that the arrangement lacked the characteristics of a bona fide loan and was more appropriately characterised as an equity contribution.

Importantly, the Tribunal held that once MIRA had accurately delineated the transaction and concluded that it was not debt in substance, it was unnecessary to undertake a further comparison with uncontrolled transactions. Accordingly, MIRA had sufficiently complied with the requirements of comparability analysis.

Issue Two: Interest on Borrowings Used to Settle Tax Liabilities

The Tribunal also considered whether interest incurred on a separate loan obtained to settle tax liabilities arising from previous audits qualified as deductible expenditure.

MIRA argued that the borrowing was not undertaken for the purpose of producing income and therefore failed to satisfy the requirements of Section 10(a) of the BPTA.

The Tribunal agreed.

While acknowledging that obtaining financing to settle tax liabilities may improve the taxpayer’s liquidity position, the Tribunal held that the payment of taxes, penalties, and fines cannot be regarded as expenditure incurred wholly and exclusively for the production of income. Consequently, interest incurred on borrowings used for that purpose does not qualify as a deductible expense.

The decision therefore confirms that expenditure aimed at satisfying tax obligations remains distinct from expenditure incurred in generating taxable income.

The Tribunal’s Decision

The Tribunal upheld MIRA’s assessment on both issues.

In relation to the related-party financing arrangement, it concluded that MIRA had properly applied the arm’s length principle and had correctly determined that the arrangement lacked the characteristics of a genuine loan. The resulting disallowance of the interest deduction was therefore justified.

In relation to the borrowing used to settle tax liabilities, the Tribunal confirmed that the associated interest expense was not incurred for the purpose of producing income and was therefore not deductible under the BPTA.

Conclusion

The decision in Case No. TAT-CA-B/2023/005 is a significant development in Maldivian transfer pricing jurisprudence. More than a dispute concerning the deductibility of interest, the case provides a detailed judicial framework for applying comparability analysis and assessing the true nature of related-party financing arrangements.

By endorsing the OECD approach to accurate delineation and emphasising the importance of economic substance, the Tribunal has provided valuable guidance for both taxpayers and the tax administration. The decision is likely to serve as a leading authority on the application of the arm’s length principle in the Maldives, particularly in relation to related-party financing transactions and the distinction between debt and equity for transfer pricing purposes.